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Executives

John Arensdorf - IR

Greg Ebel - President & CEO

Pat Reddy - CFO

Tom O'Connor - President & CEO, DCP Midstream

Analysts

Anthony Crowdell - Jeffries

Lasan Johong - RBC Capital Markets

Monroe Helm - Barrow Hanley

Ted Durbin - Goldman Sachs

Matthew Akman - Macquarie Research Equities

Faisel Khan - Citigroup

Elvira Scotto - Credit Suisse

Spectra Energy Corp. (SE) Q2 2010 Earnings Call August 4, 2010 10:00 AM ET

Operator

Good morning, my name is Jasper and I will be your conference operator today. At this time I would like to welcome everyone to the Spectra Energy Quarterly Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (Operator Instructions).

Thank you. I would now like to turn the call over to Mr. John Arensdorf. You may begin, sir.

John Arensdorf

Thanks, Jasper, and good morning, everyone. Welcome to Spectra Energy's second quarter 2010 earnings review. We're glad you joined us this morning. Leading our discussion today as usual, will be Greg Ebel, our President and Chief Executive Officer and Pat Reddy, our Chief Financial Officer. Both Greg and Pat will discuss our quarterly results, the progress and growth we have achieved year-to-date, as well as strategic opportunities we see on the horizon and of course we're going to leave plenty of time for your questions.

Before we begin, let me take a moment to remind you that some of the things we'll discuss today concern future company performance and include forward-looking statements within the meanings of the securities laws. Actual results may materially differ from those discussed in these forward-looking statements. So you should refer to the additional information contained in Spectra Energy's Form 10-K and in our other SEC filings concerning factors that could cause these results to be different from those contemplated in today's discussion.

And in addition, today's discussion includes certain non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of those measures to the most directly comparable GAAP measures is available on our Investor Relations website at SpectraEnergy.com.

With that I'll turn the call over to Greg.

Greg Ebel

Thanks very much, John, and good morning everybody. As you have seen from our earnings release this morning, Spectra Energy delivered ongoing second quarter results of $174 million dollars or $0.27 per share.

As you know, we only provide annual EPS guidance but I can tell you that our second quarter performance exceeded our expectations and we're nicely ahead of where we thought we would be at this point in the year. We feel positive about the remainder of 2010, particularly with our typically strong fourth quarter yet to come.

In addition to meeting our earnings targets, we have been busy executing on future growth plans and delivering value. Key drivers for the quarter included, first, our core fee-based businesses, U.S. Transmission and Storage, Distribution, and Canadian Gathering and Processing performed well, up more than 10% from last year's second quarter.

You will hear the details from Pat shortly but the businesses are experiencing steady, profitable growth from expansion projects. You'll also recall that the vast majority of our 2010 EBIT will come from these fee-based businesses which support our dividend.

Second, commodity prices have improved significantly from the lows we saw in the second quarter of 2009, and our Field Services segment benefited from that improvement with earnings up significantly. Third, during the quarter we continued to actively execute on our growth plan through a strategic acquisition, project expansions at our fee-based businesses as well as growing the footprint at DCP Midstream.

I'll provide more detail on these in a moment, but will point out here that in sum they affirm the compelling earnings potential and strength of our portfolio of businesses. Spectra Energy continues to be ideally positioned in terms of expansion opportunities and we're realizing substantial growth.

I'd like to talk about one of those opportunities in development, our Bobcat Storage acquisition. In mid July we announced that we signed an agreement to acquire 100% of the Bobcat Storage assets and development project for $540 million. In addition to the $540 million, we expect to invest another 400 to 450 million to fully develop the Bobcat assets. Operating capacity for the two caverns currently in service stands at 18 Bcf.

Cavern 3 is under construction and expected to be in service in 2012 and we expect the project's full capacity to grow to 46 Bcf by 2015 when all five salt domes are fully developed. As you'd expect, the incremental returns in the final two caverns developed will be substantially higher than the first three and that supports the value of this project.

Caverns 1 and 2 are operational with about 85% of their capacity contracted and we'll contract the capacity of caverns 3, 4 and 5 closer to their in-service dates consistent with how storage in this market is typically contracted. We plan to finance this acquisition and development through a combination of cash and debt and expect to close the transaction by year end, subject to Hart Scott Rodino approval.

We're extremely pleased with this opportunity which supports our goal of deploying at least $1 billion a year in gross CapEx and which, upon completion should offer returns on capital employed in the 10% to 12% range.

Here is what drew us to the Bobcat acquisition and why it will deliver premium value to our customers and investors. Natural gas storage is key to our business and this project, once complete, will ensure Spectra Energy's position as one of the largest salt dome storage providers in the Southeast.

These assets are high deliverability facilities which offer the advantage of high withdrawal and injection rates. As we've seen this summer, power producers and marketers need and value the flexibility and rapid responsiveness of salt dome storage.

We're providing customers with a lot more flexibility here. The Bobcat assets are ideally positioned in proximity to our existing storage and pipeline infrastructure and can be easily integrated into our Gulf Coast storage and pipeline assets.

The Bobcat facility is likewise well situated to serve expanding Midwest, Mid-Atlantic, and Southeast gas fired power generation requirements. As you can see on the map, Bobcat interconnects with our Texas Eastern system and with other major interstate pipelines like Transco and Gulf South, allowing Spectra Energy to provide customers with improved access to key U.S. markets.

Finally, the need for natural gas storage is apparent given the abundance of shale gas, the continued conversion of coal and oil fired electric generation to natural gas and future LNG imports. With the Bobcat completion, Spectra Energy will own almost 100 Bcf of Gulf Coast salt dome storage capacity and we expect to realize approximately $100 million of EBIT annually from the Bobcat storage assets, beginning in 2015.

Now let me move on to another significant project that we also announced in the second quarter, this one in Western Canada. In June we announced plans to meet customer demand in the Montney play of Northeast British Columbia by building a new 200 million cubic feet a day gas plant west of Dawson Creek.

The Dawson project, which is fully contracted on a fixed fee basis, is an important part of our growth strategy. It will be built in two phases with the first 100 million a day of capacity expected to be available in late 2011 and the remaining capacity in early 2013. We anticipate this project will provide returns on capital employed at the high-end of our 10 to 12% range.

The Dawson project extends our asset base in the Montney play. The Montney expansions, coupled with our significant Horn River projects, bring our investment underway in Northeast British Columbia to about $1.5 billion.

DCP Midstream also continues to move forward on a number of expansions to meet growth and customer drilling initiatives around its liquids rich footprint. So let's take a quick look at a few opportunities that they're pursuing.

In the Eagleford, DCP is laying additional pipe to connect producers to nearly 250 million cubic feet a day of its existing processing capacity which will be available, beginning in 2011. In the Permian Basin DCP is restarting and expanding its Roberts Ranch processing facility to provide up to 70 million a day of capacity for the Wolfberry region beginning in September. And they're adding new gathering and processing capacity for Avalon Shale volumes being developed now in southeast New Mexico.

In the DJ Basin just north of Denver, DCP's 125 million cubic feet a day of capacity expansion is proceeding well and should be in service by January. And in May, DCP signed a letter of intent to form a natural gas processing and liquids infrastructure joint venture to serve EQT and third party customers in the Marcellus and Huron plays. Once completed, the JV will be the preferred processor for EQT's natural gas in those areas. We expect to complete the JV agreement sometime in the third quarter.

EQT has an industry leading E&P position in the Appalachian basin with more than 3 million firmly held acres, an established cost structure and expanding gas production profile. Given DCP Midstream's strong financial position, they're able to fund growth from their own balance sheet and continue to provide us with healthy distributions that we in turn invest in our own fee-based expansion projects.

As we've mentioned many times before, Spectra Energy expects to invest at least $1 billion annually over the next several years in fee- based expansion projects. We have a great backlog of these projects. So let's take a look at some of those.

I won't go through this map in detail, but we like to share it with you regularly as it provides a clear view of the projects we have in execution as well as future opportunities for ongoing growth. In addition to the projects I just mentioned, we're making good progress on our full expansion roster. We have added a new project in Ontario, the Jacob Storage project, expected to be in service by the second half of 2012.

The Hot Spring lateral in Arkansas is an expansion of our Texas Eastern system and will provide firm capacity to KGen's Hot Spring power plant. In April our board approved the Northeastern Tennessee Project or NET. So we've moved that one into execution.

NET will provide transportation service to TVA's new gas-fired power plant and is slated to be in service during the second half of 2011. We've talked in previous quarters about the growth potential associated with our Fort Nelson projects. As we forecasted in January, these projects should begin contributing significant earnings in the fourth quarter.

That's a quick snapshot, but I think it gives you a sense of the momentum we're experiencing across all segments as well as confidence in our ability to deliver 2010 to 2012 compound annual EPS growth in the 8 to 10% range.

I'm pleased with the quarter and where we stand at the half year mark. We're in line with, and frankly ahead of where we thought we would be on all fronts -- financial, strategic, safety and operational. We still of course have our important fourth quarter ahead of us, but we are in a great place to deliver on expectations for the year.

So with that let me turn things over to Pat who will walk you through the numbers for the quarter.

Pat Reddy

Thank you, Greg, and good morning everyone. As we announced earlier today, Spectra Energy reported second quarter 2010 ongoing earnings of $174 million or $0.27 per share compared with 141 million or $0.22 per share in the second quarter of 2009.

And as Greg told you, this year-over-year increase of more than 20% reflects the solid progress we have made on executing our growth projects, a more favorable Canadian exchange rate and improved commodity prices this year as compared to last year.

We're very pleased with this progress in the first six months of 2010. While we benefited from macro factors like higher commodity prices and a stronger Canadian dollar, we also continue to focus on factors that we can influence.

For example, we continue to see increases in EBIT from projects previously placed into service and we expect to place six projects totaling 900 million of investment in full or partial service by year end generating ROCE's greater than 12%.

We've controlled our operating and maintenance expenses to levels consistent with our previous guidance and we've been opportunistic in financing the business by timing our debt issuances to capture historically low interest rates.

Our core fee-based businesses performed in line with our expectations and we expanded our gathering and processing contracted volumes in Western Canada. At the same time we maintained our balance sheet strength and improved our debt coverage ratios since the end of 2009. These accomplishments helped us to buffer certain headwinds in the first six months and position us to meet or slightly exceed our expectations for the full year.

We know many of you focus on EBITDA. So the next slide provides this information by business segment. Ongoing EBITDA for the quarter was $657 million, compared with 579 million in the second quarter of 2009. The year-to-date increase of almost $300 million reflects the strong cash generation capacity of our business with every segment delivering solid results.

Let's now take a look at our performance by business segment beginning with U.S. Transmission. U.S. Transmission reported second quarter EBIT of $223 million, compared with 234 million in the second quarter of 2009. Second quarter 2009 results included a net $24 million benefit related to project development costs. Before the effect of this 2009 item, EBIT increased by over 6% compared with last year's quarter.

During the 2010 quarter the segment benefited from business expansion projects previously placed into service including GulfStream Phase III, Algonquin J-2 and Northern Bridge. In addition, the segment benefited from higher processing revenues as a result of higher prices.

Now let's move onto Distribution. Even in these challenging economic times Union Gas continues to make solid contributions to our earnings and to grow their customer base. Distribution reported second quarter EBIT of $73 million, compared with 40 million in 2009.

This improvement is primarily due to a stronger Canadian dollar and lower operating fuel costs. In addition, the second quarter 2009 results included an $11 million charge for a cumulative adjustment to the 2008 earnings sharing required under Union Gas's incentive rate making methodology.

So let me now turn to Western Canada. Western Canada Transmission and Processing reported second quarter EBIT of $69 million, compared with 58 million in 2009. The segment benefited from improved results in the base gathering and processing business, primarily driven by additional contracted volumes from expansions including Fort Nelson, South Peace Pipeline and West Doe. The segment also benefited from the effect of a stronger Canadian dollar.

These improvements were partially offset by lower earnings at Empress due to a scheduled maintenance shutdown that kept the plant out of service for most of the month of May. The Empress frac spread for the quarter averaged $8.03, compared with $4.98 during last year's quarter.

However, we experienced higher extraction premiums paid to shippers this quarter which dampened the effects of the increased frac spread. Indeed we continue to see much higher than historical extraction premiums at Empress.

Let's turn now to Field Services. Our Field Services segment, which represents Spectra Energy's 50% interest in DCP Midstream reported second quarter EBIT of $58 million, compared with 24 million in the second quarter of 2009. The increase in ongoing earnings was primarily driven by higher commodity prices.

During the second quarter of 2010 both higher crude oil prices and the NGL to oil relationship produced an NGL average price of $0.91 per gallon, versus $0.62 last year and NYMEX natural gas averaged $4.09 per MMBtu, versus $3.50 during the same period in 2009.

Second quarter results also reflect the benefit of non-cash mark-to-market gains on hedges used to protect distributable cash flow at DCP Midstream's master limited partnership. The increase in earnings was partially offset by lower marketing results and the timing of higher planned, repair and maintenance costs this year.

DCP Midstream paid distributions of $112 million to Spectra Energy during the second quarter and we're on track to receive the anticipated 300 million of total distributions for the full year. In the first six months we've seen NGL prices average $1.03.

With the recent softening we have seen, it looks like the full year price will be close to our forecast of $0.95 a gallon and at this point in time it appears that DCP Midstream's 2010 EBIT contribution will be about where we forecasted it when we had our meetings with you in January.

Now let me turn to additional items for the quarter. Other reported net costs of $16 million in the second quarter of 2010 compared with net costs of 12 million in last year's quarter. Interest expense was 158 million, compared with 146 million in the second quarter of 2009. This increase is primarily the result of a stronger Canadian dollar.

The second quarter's effective tax rate was 29%, compared with 30% last year. In terms of the stronger Canadian currency and its positive effect on our Canadian businesses during the quarter, I'll remind you that FX also affects interest expense and income taxes. The after tax currency effect on all of these factors provide an increase to second quarter net income of about $8 million, compared with the second quarter of last year.

At the end of the second quarter our debt to total capitalization ratio stood at 55.2%. We expect to be able to fund our CapEx program through a combination of internally generated funds and debt while staying within the 55 to 60% leverage range that we targeted. And at the quarter's close we had total capacity under our credit facilities of $2.7 billion and available liquidity of nearly 2 billion.

Just last month we executed two very successful debt issuances at our Canadian businesses. At West Coast we issued C$250 million of 10-year notes at a coupon of 4.57% and at Union Gas we issued 250 million of 30-year notes at 5.2% which represents the lowest 30 year coupon in Union's history. The proceeds of these issuances will be used to refinance current maturities and to fund expansion of our Canadian businesses.

Both Moody's and S&P affirmed our investment grade ratings this quarter. Our strong financial position provides us with tremendous flexibility and reach and we can choose between a number of financing options including, when appropriate, using our equity at Spectra Energy Partners to finance growth. So we've a lot of arrows in our financing quiver and we'll be sure to use the best ones at the right time.

So just to wrap up, Spectra Energy delivered a second quarter of solid results from all of our business segments. We're comfortable with where we are at mid-year which is actually a bit ahead of where we'd expected to be. Although our fourth quarter earnings will depend on both weather and commodity prices, we feel very good about being in a position to exceed our EPS guidance for the year.

We've made good progress on our capital expansion plans. Our core businesses delivered admirable performance and we captured the positive effects of higher commodity prices at our DCP Midstream business. We described for you how well positioned we are in terms of expansion opportunities; real, substantial, fee-based growth that affirms the strength of our diverse and robust portfolio.

We're equally well positioned financially with strong cash flow, stable investment grade credit ratings, ample liquidity, and excellent access to capital needed to fund our growth. Again, Spectra Energy delivered a great first half of the year and we have every confidence that we'll have a solid second half as we continue to focus on strategic execution, expansion and earnings growth.

So with that, Greg and I would now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Anthony Crowdell.

Anthony Crowdell - Jeffries

Good morning. Some questions on the NGL pricing for field services. Is there any concern with all of the shale plays or more production you're seeing in gas, therefore more production in liquids that we're going to keep seeing further downward pressure on the NGL prices going forward?

Greg Ebel

Well I think we remain pretty positive on NGL prices from a long-term perspective. Obviously we've come back a long way from the last year. I think in the second quarter you're contrasting against what was a very strong first quarter and I think there were some factors that may have pushed it down.

Obviously people were more concerned about the economy. People weren't sure where autos, et cetera, were going. We had a number of the steam crackers that had outages that lasted longer which allowed for a build up in inventories which kept prices down.

But I see things like increases in auto sales up 5%. That's important for plastics. That's good for NGLs. Obviously we're going to head into the winter and crop drying and exports. So I think we feel very comfortable about our $0.95 overall forecast for the year.

Longer term I think the big driver is how the economy moves forward, frankly and what I see is the chance of a double dip probably declining. It's still out there. I would suggest that bodes well for liquids prices even with the new supplies coming on.

Anthony Crowdell - Jeffries

Just for forecasting purposes, is it more accurate to use, say, Conway pricing for Field Services or should we use like Belvieu pricing or just a blend of the two?

Greg Ebel

It is really a blend of the two. Tom is on the line. I don't know, Tom, if you want to comment on that. Generally we've got so many contracts and obviously impacted by both pieces.

Tom O'Connor

Thanks, Greg. I think generally what you can use is a blend of the two and somewhere -- roughly 50/50 to 55 Belvieu, 45 Conway would probably be a fair combination.

Anthony Crowdell - Jeffries

Great. Thank you for your help, guys.

Greg Ebel

Thank you.

Operator

And your next question comes from the line of Lasan Johong.

Greg Ebel

Hey Lasan

Lasan Johong - RBC Capital Markets

How are you?

Greg Ebel

Good.

Lasan Johong - RBC Capital Markets

Excellent. The storage levels for natural gas is getting kind of peaky. Are you starting to see strains or feel the strains and how is this having any -- is this having any positive pricing action on your side going forward?

Greg Ebel

Well I haven't seen a ton of pricing action at this point in time. I think you got a couple of unique things going on. One, you've got what I'm told is a kind of three sigma move in weather obviously, and that's really making the current prices higher than what you'd typically see vis-à-vis the fall or even the Oct.-Jan. type spreads and that's hurting storage prices right now.

But I think the long-term focus for us, and we contract as such, we do some short-term contracts, some long-term contracts, some medium term contracts, is really the overall fundamentals of the storage market. And that we see continuing to be positive from a gas perspective. But yeah look, I think once the weather settles down, I think you'll see a more typical fundamental type structure around gas prices and hence around storage.

Lasan Johong - RBC Capital Markets

So even though NAT gas storage levels are close to record highs, this is not having an effect because the current weather is hot and people are selling into the current weather?

Greg Ebel

Right, that's exactly what's happening. So, then you end up, you have the current month and the front month actually high, people are going to sell that gas as opposed to put it into storage and as such you continue to see storage high. And then you go back once the summer ends, and it will end, you will go back to a typical, I would suggest, where you will find the back end of the curve higher as you look at the Oct - Jan. type of pricing.

Lasan Johong - RBC Capital Markets

Generally speaking, are you continuing to see drilling ramp in shale areas and backing away from conventional areas?

Greg Ebel

Yes, we are. Particularly in places like the Eagleford and the Permian. Again, Tom is on the line and he could probably give you some good insights on that. So, Tom, do you want to throw in on that?

Tom O'Connor

Sure, yes. I think what we're continuing to see is a growth in rig counts primarily focused on our footprint around the liquids rich plays. If you were to parse our drilling, we have seen a recovery but not as quick a recovery in places like the Mid-continent. And then you look at places like the DJ and Denver where rig counts have effectively doubled this year. Activity in the Permian is up very significantly this year and since the trough of last year. And then of course the rig count continues to grow in the Eagleford as we move through the year, and I think people expect that to continue. So, for us it's primarily liquid centric, more conventional areas, drier gas areas, rig counts have recovered but not quite as quickly as the liquids rich areas.

Greg Ebel

The other positive thing about that, Lasan, is obviously in the liquids rich areas that's obviously a higher margin business for us than the dry gas areas.

Lasan Johong - RBC Capital Markets

Of course, one last question for me. Industrial activity, are you starting to see some pickup in that area vis-à-vis more demand or as the latest volume increases more driven by weather?

Greg Ebel

Yes, I think it is more weather. I think probably a good indicator of industrial demand is job growth and as you know that's not exactly spectacular. One of the good insights we get out of places like Union Gas or LDC, we saw 16,000 new customers get attached. That's residential, but obviously that's an indicator better than what we would have expected and seen. So, I think what we're starting to realize, again, after what I think is a general and pretty robust first quarter, second quarter a little bit nervousness out there in the economy, that I think people are coming to realize that, look, this is a steady but a grind nonetheless up as opposed to a rocketing up. And I think that's probably what we're going to have, we're going to have a pretty slow grind up. The positive thing is it is a grind up now as opposed to a grind down.

Lasan Johong - RBC Capital Markets

Yes. And it puts less strain on future issues. Thank you very much. Appreciate your help.

Greg Ebel

Thanks Lasan.

Operator

And your next question comes from line of Monroe Helm.

Greg Ebel

Hey, Monroe.

Monroe Helm - Barrow Hanley

Good quarter, just a quick question on your storage operation. It is a pretty significant investment for you. It's going to turn out to be $1 billion by 2015, yet the rate of return is at the low end of your targeted range. Does that have anything to say about other opportunities you're seeing now maybe not being as robust as the rates of return that you'd hope to see on some of these other opportunities?

Greg Ebel

No, I don't think so. The Bobcat acquisition is a bit of a hybrid. If obviously we went out and built it on our own and we took it from the start, you could have probably built it at, call it, 7 or 8 times EBITDA multiples. If you waited until it was fully built out, you look at acquisitions, people might be in the 10, 12 times multiple. We're buying it part way through, so it is a 9 or 10 times a multiple. I think we paid a fair value for it and we'll extract premium value for our investors.

Versus other projects that we see, for example in Western Canada, we see very nice robust returns above our targeted 10% to 12%. So, then when you blend that with different projects, I think we feel very confident that on a portfolio basis we're still going to be very much at that 10% to 12% basis and for the next couple of years, frankly, we'll see returns much more in the even 12% to 14% range on the expansion projects as a portfolio.

Monroe Helm - Barrow Hanley

Okay. Thanks.

Greg Ebel

Thank you.

Operator

And your next question comes from the line of Ted Durbin.

Greg Ebel

Hey,Ted.

Ted Durbin - Goldman Sachs

Hi, there. Just talk a little bit about financing plans in more detail. With the acquisition of Bobcat you got the increased capital spending. Where do you see credit metrics? And if you think about the strong cost of capital down at your MLP, would you consider a dropdown there?

Pat Reddy

Ted, thanks for that. In January, when we gave our guidance, we mentioned that we do an internal three-year plan that goes out through 2012. And that plan showed that even with incremental growth CapEx each year of at least $1 billion that we wouldn't need to issue equity to preserve our credit metrics and our credit rating. And as we looked at the Bobcat acquisition, that really doesn't change. For a Company with $24 billion in assets and little bit about 9.8 billion in debt today, targeting around 11 billion of debt by year end, an acquisition in the $0.5 billion range really doesn't move the needle much on our FFO to debt or FFO to interest.

And so we can, and expect to, finance the acquisition with a combination of internally generated cash and debt. And then the other 400 to 450 million for buildout CapEx comes over a period of four to five years, and it is something that we think we can absorb, again with debt, particularly as we're seeing such attractive interest rates.

With respect to Spectra Energy Partners, it is always a possibility and it is something that we look at concerning the attractiveness of dropping down assets and using their currency. And then, frankly, taking those proceeds to reduce debt at Spectra Energy and to issue some equity at Spectra Energy Partners which improves our balance sheet overall. So, while we don't have anything to announce today or any immediate plans, that is part of what we'll look at between now and year end.

Greg Ebel

I think just to add to Pat's color, I think that's the real value of having multiple financing nodes. That's available to us today, and we'll utilize it. And I guess the key for us is what's the lowest cost of capital at any point in time let's utilize that and we continue to have basically all of those factors available. I think the other thing is Pat has been able, the Treasury team, to go out and raise debt this year at very favorable rates. Obviously that improves your coverage ratios as well, too, less interest per EBIT and FFO.

Pat Reddy

I think we mentioned that the fundamental reason that our credit metrics improved in our three-year plan is that we've got some very attractive investments in Western Canada, including Fort Nelson where the EBIT even though the CapEx is back-end loaded the EBIT begins to come on, even at the end of last year and building into this year. So, the returns from those projects are good and the cash flow is good, and that really isn't changed by Bobcat which, as Greg mentioned, really rolls out over a four to five-year period.

Ted Durbin - Goldman Sachs

That's very helpful. Thanks, if I could just ask one more. You said you're ahead of your plan for the year. You're halfway through. There are certain segments here where you're tracking above or below guidance and why would you be above or below?

Greg Ebel

Well I think obviously we have done better in the first half of the year than on NGLs, so that helps. I think the average for the year is around $1.03 year-to-date, and we'd expect $0.95 on a full year basis, so that's been beneficial. We have actually done well on the interest side. Currency has helped, as well and then the expansion projects, just having those delivered, some of them a little bit less than budget. Basically I would say, both from a things we can control and things we can't control, they're all running very much full out. So, it is a positive situation when you can develop projects, bring on new projects, and also have the factors you can't control like interest rates and the commodity go your way, as well. So, that, I think, bodes very well for the first half of the year. And the key, as you know, really is the fourth quarter. Let's have the winter coming. Let's get our projects in on time and on budget which we expect, and have commodity prices be in line with our expectations, and that bodes well.

Pat Reddy

And, Ted, as Greg said, we captured about 50 million of incremental EBIT from expansion projects year -to-date, about 30 million at U.S. Transmission and 20 million in Western Canada. And then on the cost front there is a good story there, as well, year- to-date.

Our costs versus the costs that were embedded in our guidance are down about $38 million. So, those are things that we have some control over and while part of that is timing and we'll give a little of it back in the second half of the year, it will help us to offset the fact that our forecast had increasing commodity prices in the second half of the year. And obviously the opposite's happened. The first and second quarters were a little bit higher than maybe the balance of the year, but again we still see NGLs coming in around $0.95 on average. So, it really shows the beauty of the portfolio where one element may be down but we've got other levers to pull.

Ted Durbin - Goldman Sachs

Okay. Great. Those are my questions. I appreciate it.

Operator

(Operator Instructions). The next question comes from the line of Matthew Akman.

Greg Ebel

Hey, Matt.

Matthew Akman - Macquarie Research Equities

Hi, Greg. First quick question and then maybe a bigger picture one. The quick question I have is on Union Gas. You guys had a really good quarter there and attribute it to lower operating fuel costs. I am not actually sure I even know what that means. But I presume it means the costs were lower and under incentive regulation, it boosted earnings for the Company. But maybe you could expand on that?

Greg Ebel

Sure. Really it means we used less fuel than we thought and cheaper fuel than we thought in terms of pushing gas through the pipeline, so that was the real benefit there. It is not really an IR related item, and it was probably around $8 million or so.

Matthew Akman - Macquarie Research Equities

Okay. Thanks for that. Maybe this one is for Tom if you are still on the line. But it really relates to potential opportunities in moving liquids out of Marcellus. We have seen a couple recent announcements on the Bakken and where ethane and other liquids might go, even some of that moving back to Alberta, which is interesting. Do you have any thoughts on where it might move and how it might move out of Marcellus? And are there pipelining opportunities maybe for Spectra in that regard?

Tom O'Connor

Thank you, Matthew. I think right now, as you know, there is a number of proposals being kicked around, some bringing the liquids back to Belvieu. There is going to the East Coast and then shipping to Belvieu some going to Sarnia and then others going back further west.

At this point we're in a mode more of evaluating on the front end what do we think the liquids production is going to be and the timing of the need for an NGL solution out of the Marcellus. I think it is early on that, and I think the opportunity is going to be there, I think the need is going to be there, but we're at this point trying to evaluate the timing vis-à-vis what the drilling expectations are, what the quality of the gas is, so what the overall need will be.

And then we're at this point I think pretty flexible on where we think the ultimate solution is going to be. The good news is that there are several, or at least a few, opportunities which appear to be economic and realistic. And from our standpoint through our joint venture opportunity with EQT we expect to be handling a significant amount of liquids, so we think we can influence what ultimately gets done and at the end of the day would like to participate in the build-out of that solution.

Greg Ebel

I think Matt, the other thing you have is obviously if it is a major liquids line and large diameter, you end up having opportunities for Spectra as well. So, you get the nice complement between DCP and the processing side and Spectra on potential amount of liquids side. And the benefit, obviously, for folks like Equitable, EQT, they work with both those very closely, both important customers. So, I think the idea and what we're trying to do at DCP and Spectra is really try to offer full cycle solutions here.

Tom O'Connor

I think as you know one of the things at EQT, what interested EQT in DCP Midstream and as part of the Spectra enterprise is our liquids capability in terms of handling and getting good values for liquids. But also the financial capability of the enterprise and its ability to bring not only the technical expertise but the capital to what could be a fairly sizable NGL solution.

Matthew Akman - Macquarie Research Equities

Okay. Thanks. That's what I was looking for. And my last question relates to dividends and the dividend policy. I guess and maybe I guess this is for Greg here. You talked about earnings likely being higher than guidance this year hopefully if the back half plays out. There is a big appetite for yield in the marketplace that we have seen play out in MLPs and your MLP products. How does that bear on the dividend then and for potential dividend growth into next year?

Greg Ebel

Obviously, as we start putting the plans together for next year and talking to the Board about that, I think both obviously management and the Board really recognize the value of dividends and how important that is to the value proposition. So, that's definitely something we'll be taking up, and obviously with the steady earnings growth like to be able to see us have an opportunity to consider that. So, definitely something on the radar screen, Matt.

Matthew Akman - Macquarie Research Equities

Okay. Thanks, guys. Those are my questions.

Greg Ebel

Okay. Thanks.

John Arensdorf

Operator, do we have another question?

Operator

Your next question comes from the line of Faisel Khan.

Greg Ebel

Hi, Faisel.

Faisel Khan - Citigroup

Hi, how are you doing? Good morning.

Greg Ebel

Good.

Faisel Khan - Citigroup

Just a couple nits and nats, on the U.S. Transmission side, the operating and maintenance costs at $165 million, even if I add back the $24 million for last year, it still looks like O&M is fairly high compared to last year. Anything going on there in terms of development costs?

Pat Reddy

No, Faisel. There is some timing during the year for turnarounds, for integrity spending. And we're actually, as I mentioned a minute earlier, we're about $38 million at the corporate level under spent on O&M. But U.S. Transmission is basically right on budget.

Faisel Khan - Citigroup

Okay. Got you. And then on the distribution segment, I know you talked about the lower operating fuel costs. Was there any impact from this higher pipeline throughput that you guys had of roughly up 40% over last year? It looked pretty strong. I am wondering what's driving that despite lower heating degree days.

Greg Ebel

No, really not much. Remember that that's all contracted, so we would have volumes go through. Obviously it might have been a little bit of a weather impact. It didn't get hot until later on in the summer, but really doesn't have much of an earnings impact given the nature of the way we contract for those services.

Faisel Khan - Citigroup

Got you. On the Western Canadian side, the Empress inlet volumes, I know you talked about a 25-day turnaround for that facility. It still seems to be down 50% over last year, seems a little bit higher down time compared to the number of days you had that plant down for.

Pat Reddy

Yes. I think you found the overall volumes coming out of Western Canada, the border volumes were down from call it 5 Bcf a day to the 4 Bcf range. So, when you combine the two together, that actually was the impact. And obviously that meant we had to pay a little higher premiums to get gas through Empress which obviously had an impact. Very much in line with what we thought we would earn there this year, but you might have thought that with the higher frac spread you would actually even be doing better there but when you have to pay to get the gas coming through your plant that eats a little bit on the margins.

Faisel Khan - Citigroup

Okay that makes sense. And then on the Bobcat Storage assets, would there be any ancillary benefits to the asset as you connect those storage assets to your main line?

Greg Ebel

I think that's one of the key things. When we first bought MHP Storage, what you're able to do, again, is offer customers so much optionality and flexibility for them to use services, not only through the assets we have existing today, allowing access to the pipes but now Transco, Gulf South also giving customers access to those pipes. I think that's the real benefit and why we'll be able to realize premium values out of that asset as we build it up.

So, when you think about all the power changes that will go on in the Southeast, you think about the gas flows, you think about the pipelines that now interconnect with what will be 100 Bcf of storage and I think we'll be able to make that asset hum quite nicely.

Faisel Khan - Citigroup

I guess that would be outside the $100 million that you talked about that Bobcat could earn in 2015?

Greg Ebel

We'll see how we contract the thing up as we go, but obviously I think we have been appropriately conservative with our assumptions there and the storage guys will get out there and hunt and do everything they can to add to that.

Faisel Khan - Citigroup

And last question on NGL supply growth. Over the last two quarters what part of the barrel have you seen the most supply growth in, meaning ethane, propane, butane, the different parts of the barrel? And what do you see the rest of this year?

Greg Ebel

It has really been a big growth on the ethane side and you see that across the board. And as you see more and more activity in liquids rich areas I would expect that's where you will see it. Tom, any comment on that either with respect to other parts of the barrel, propane, et cetera?

Tom O'Connor

No. I think both propane and ethane have moved up and I think the expectation you're seeing with additional cryogenic facilities coming on over the next couple years is that those will continue. There is a fair amount of variability between formations and geographic locations, and I think we're all still trying to get our arms around that as some of the newer plays come online. But in general those two have moved up and that's simply, on the ethane side, a matter of the number of new cryo facilities coming on.

Faisel Khan - Citigroup

And do you see the fees you're charging for fractionation, are those fees moving up over time, do you think?

Tom O'Connor

The fees on fractionation in general have moved up. I think, as you know, they're in some cases up very significantly. It is enough to support -- and we're encouraged by this quite honestly -- it is enough to support new fractionation facilities being contracted longer term, enough to support them getting built. There is a few that will come online here in the next six months or so and now folks are talking about additional frac facilities and additional expansions in the Gulf Coast that I am sure you are aware of. So the fees are there to support those, provide decent returns, and we're encouraged by that because we don't want to see a bottleneck at that point in the system.

Faisel Khan - Citigroup

Are you seeing some of those profits drop through to your bottom line at DCP?

Tom O'Connor

Our frac facilities are fairly modest. We have the opportunity to participate in some expansions. The answer is yes, but in terms of the other aspects of our business, the most important contributions to our growth are going to be the things that Greg mentioned, our expansions in the Permian, our new facility in the DJ that's going to come on here in January, and our expectations for growth here in the near term in the Eagleford and the Marcellus.

Faisel Khan - Citigroup

Great. Thank you very much for your time. Appreciate it.

Tom O'Connor

Thanks.

Operator

(Operator Instructions). Your next question comes from the line of Elvira Scotto.

Greg Ebel

Good morning.

Elvira Scotto - Credit Suisse

Hi, good morning. A couple of questions to follow up on the Bobcat acquisition. Number one, can you talk a little bit about what kind of process this was? Was this a negotiated deal? Was there an option and if there was any bidding, how competitive it was?

Greg Ebel

I am probably limited in what I can say under various confidentiality agreements, but they had run a process. This is a group of folks that have actually developed storage a couple of times. In fact they developed our MHP asset when we bought it off of them. So it's private equity that had gone out and taken risks to develop this. There is always competition in assets, that's for sure. And then in the end it was obviously just a negotiated deal between ourselves and them.

Elvira Scotto - Credit Suisse

Okay. Great. And then just bigger picture and longer term, when you think about storage and you have a couple of storage focused MLPs and you see a lot of expansion announcements, if you look out longer term, say five to ten years, what do you think the supply demand dynamics are going to be for storage? You touched on it a little bit, but maybe some additional thoughts on that, and thoughts on maybe where the storage is located and the type of storage.

Greg Ebel

I think you hit on a couple of them. If you go out 2015, maybe there is going to be about 5, maybe 5.1 Tcf of storage versus today what would be there about 4.9. So not a huge massive increase in storage. You hear about lots of announcements. Obviously two critical components. One is it's salt dome storage which is what this is that we bought that has high deliverability, high flexibility, injection and withdrawal rates which is so critical to gas fired generation which is going to be increasing. And then you have the other kind of storage which is reservoir storage which is what would be like our Union Gas storage which is obviously valuable, particularly given its location closer to the market typically. but very different dynamics, as well. I think what you'll continue to see, and the value proposition, you will continue to see volatility, season-to-season, basis-to-basis around natural gas and that's where the real value opportunity exists. On top of that you see an increasing amount of gas-fired generation which is going to demand that type of high deliverability type service. So if you look in the Gulf Coast region where the Bobcat asset is, call it five years out, a T-and-a- half of storage of which we'd make up, call it 75 Bcf, so we're still a pretty small component of the storage piece.

Elvira Scotto - Credit Suisse

Okay. That's helpful. Thank you.

Operator

There are no further questions at this time.

John Arensdorf

All right. With that I would like to thank everyone for joining our call today. I will remind you that on Tuesday, August 17th we're going to be in Boston for breakfast and in New York for lunch.

You should have received an invitation to that. If you haven't, let us know and we'll see to it that you do. If you would let us know whether you plan to attend, that would be great, and we'll look forward to seeing you then. As always, if you have any further questions, please feel free to either call Patti Fitzpatrick or me. With that, thanks for joining the call today.

Operator

And this does conclude today's conference call. You may now disconnect.

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Source: Spectra Energy Corp. Q2 2010 Earnings Call Transcript
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